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INTERMEDIATE ACCOUNTING 2

LIABILITIES
LIABILITIES
LEARNING OBJECTIVES:
1. Understand the concept of
liabilities.
2. Describe the nature and type
of current and noncurrent
liabilities.
3. Explain the issue of long-term
debt falling due within one
year.
LIABILITIES
LEARNING OBJECTIVES:
4. Explain the issue of breach of
covenants attached to a long-
term debt
5. Describe formulas in
computing bonus to officers
and employees.
 What are liabilities?

•Liabilities are present obligations

of an entity to transfer an
economic resource as a result of
past events.
 ESSENTIAL CHARACTERISTICS

•The entity has a present

obligation
–The entity has a duty or
responsibility and it has no practical
ability to avoid it
–The entity liable must be
indentified but it is not necessary
that the payee to whom the
obligation is owed be identified
 PRESENT OBLIGATION

•Legal Obligation
–Obligations that are legally
enforceable as a consequence of
binding contract or statutory
requirement.
•Constructive Obligation
–Obligations that arises by reason of
normal business practice, custom
and desire to maintain a good
business relations or act in equitable
manner.
 ESSENTIAL CHARACTERISTICS

•The obligation is to transfer an

economic resource
–A liability is an obligation to transfer
an economic resource and not the
ultimate outflow of economic benefit
–The outflow of economic benefit no
longer need to be expected
–Economic resource is the asset that
represents a right with a potential to
produce economic benefits
•Example: To pay cash, transfer non cash
assets, or provided services.
 ESSENTIAL CHARACTERISTICS

•The liability arises from a past

event
–There was a past transaction that
gives rise to an obligation –
obligating event
–Liability is not recognized until it is
incurred
 EXAMPLES

•Accounts payable to suppliers for

the purchase of goods
•Amounts withheld from
employees for taxes and for
contributions to the SSS,
Philhealth, & Pag-ibig
•Accruals for salaries, rent,
interest, etc.
•Cash declared but not paid
 EXAMPLES

•Deposits and advances from

customers
•Debt obligations for borrowed
funds – notes, mortgages, bonds
•Income tax payable
•Unearned revenues
 MEASUREMENT OF CURRENT LIABILITIES

•Recorded and reported at face

amount
•Conceptually, all liabilities are
initially measured at face value and
subsequently measured at amortized
cost
•However, for current liabilities, they
are not discounted anymore because
the difference is usually not material
(immaterial) therefore ignored.
 MEASUREMENT OF NONCURRENT
LIABILITIES

•Initially measured at face value

and subsequently measured at
amortized cost
•Interest bearing – it is initially
recorded and subsequently
measured at face amount.
 CURRENT LIABILITIES

• An entity shall classify a liability as

current when:
1. it expects to settle the liability within its
normal operating cycle;
2. it holds the liability primarily for the
purpose of trading;
3. the liability is due to be settled within
twelve months after the reporting
period; or
4. the entity does not have an
unconditional right to defer settlement
of the liability for at least twelve months
after the reporting period.
 PRESENTATION OF CURRENT LIABILITIES

• Trade and Other Payable

• Current Provisions
• Short-Term Borrowing
• Current Portion of Long Term
Debt
• Current Tax Liability
 NONCURRENT LIABITIES

•Residual definition
•All liabilities not classified as current
are classified as noncurrent liabilities
•Examples
–Noncurrent portion of long term debt
–Finance lease liability
–Deferred tax liability
–Long term obligation to officers
–Long term deferred revenues
LONG TERM DEBT CURRENTLY MATURING

Per PAS 1, liability which is due to be

settled within 12 months after
the end of reporting period is
classified as CURRENT, even if:
▪ The original term was for a
period longer than 12 months
▪ An agreement to refinance or to
reschedule payment on a long
term basis is completed after the
end of the accounting period and
before the FS are authorized for
issue.
LONG TERM DEBT CURRENTLY MATURING

Refinancing – the replacement of

an existing debt with a new one
but with different terms i.e. an
extended maturity date or a
revised payment schedule
 EXCEPTIONS

•If the refinancing on a long term

basis is completed on or before
the end of the reporting period,
the refinancing is an adjusting
event and therefore the obligation
is continued to be classified as
NONCURRENT.
 EXCEPTIONS

•If the entity has the discretion to

refinance or roll over an
obligation for at least twelve
months after the reporting period
under an existing loan facility, the
obligation is classified as
noncurrent even if it would
otherwise be due within a shorter
period.
 EXCEPTIONS

•If the entity has an unconditional

right under the existing loan
facility to defer settlement of the
liability for at least twelve months
after the reporting period, the
obligation is considered as part of
the entity’s long-term refinancing.
 LIABILITIES PAYABLE ON DEMAND

Liabilities that are payable upon

the demand of the lender are
classified as current.
 COVENANTS

•Covenants are often attach to

borrowing agreements which
represent undertakings by the
borrower
•Covenants are restrictions on the
borrower as to undertaking
further borrowings, paying
dividends, maintaining special
level of working capital, etc.
 COVENANTS

• Under these covenants, if

certain conditions relating to
borrower’s financial situation
are breached, the liability
becomes payable on demand
• Thus, classified as a CURRENT
LIABILITY.
 COVENANTS

•PAS 1, P.74 states that such a

liability is classified as current,
even if the lender has agreed,
after the end of the reporting
period but before the financial
statements are authorized for
issue, not to demand payment as
a consequence of the breach.
 COVENANTS

•PAS 1, P.75 states that such a

liability is classified as noncurrent, if
the lender has agreed on or before
the end of the reporting period to
provide a grace period ending at
least twelve months after the end of
the reporting period.
•Grace period is the a period within
which the borrower can rectify the
breach and during which the lender
cannot demand immediate payment.
 ESTIMATED VS. CONTINGENT LIABILITIES

• Estimated Liabilities
– Obligations which exist at the end of
reporting period although the
amount is not definite
• Contingent Liabilities
– A possible obligation that arises from
past event and whose existence will
be confirmed only by the occurrence
or non-occurrence of one or more
uncertain events not wholly within
the control of the entity.
 ESTIMATED LIABILITIES

•Existing obligation
•Amount is not definite
•Due date is not definite
•In some cases, exact payee
cannot be identified or
determined
•Examples:
–Estimated liability for premiums,
award points, warranties, gift
certificates and bonus
 CONTINGENT LIABILITIES

• Contingent liabilities are not

recognized because:
– It is not probable that there will
be a transfer of economic
resources
– The amount of obligation cannot
be measured reliably
 RANGE OF OUTCOME

• Probable
– Likely to occur, more than 50%
likely
• Possible
– Less likely to occur, 50% or less
• Remote
– Least likely to occur, 10% or less
 TREATMENT OF CONTINGENT LIABILITY

• A contingent liability is not

recognized in the financial
statements. It shall be disclosed
only.
• Required disclosures:
– Brief description of the nature of the
contingent liability
– An estimate of financial effects
– An indication of uncertainties that
exist
– Possibility of reimbursement
 DEFERRED REVENUE

•Income already received but not

yet earned
•If realizable within one year –
current liability
•If realizable in more than one
year – noncurrent liability
 GIFT CERTIFICATES PAYABLE

•Malls, department stores, and

supermarkets sell gift certificates
which are redeemable in
merhandise
 GIFT CERTIFICATES PAYABLE

PROFORMA JOURNAL ENTRIES:

When the GCs are sold:
Cash xx
Gift certificates payable xx

When the GCs are redeemed:

Gift certificates payable xx
Sales xx
 BONUS

•A special compensation given to

key officers and employees for
superior income realized during
the year and in order to motivate
them to work toward the success
of the entity
•This compensation plan results in
liability that must be measured
and reported in the financial
statements
 BONUS COMPUTATIONS

•Bonus is based on income before

bonus and before tax
B = BR (IBBT)
•Bonus is based on income after
bonus and before tax
B = BR (IBBT-B)
 BONUS COMPUTATIONS

•Bonus is based on income after

bonus and after tax
B = BR (IBBT-B-T)
T= TR (IBBT-B)
•Bonus is based on income after
tax but before bonus
B = BR (IBBT-T)
T= TR (IBBT-B)
 BONUS COMPUTATIONS

Given data:
IBBT = 600,000
BR = 20%
TR = 30%
 BONUS COMPUTATIONS

Class, I will just put the correct

answers ha? Kindly solve on
your own so that you will know
the process.
1. B = 120,000
2. B = 100,000
3. B = 73,684
4. B = 89,362
 REFUNDABLE DEPOSITS

•These represents cash or property

received from customers which are
refundable after compliance with
certain conditions
•An obligation of a company to
refund amounts previously collected
from customers as deposit
•It may be classified as current or
noncurrent depending on the
purpose of the deposit
  QUESTIONS????
 REACTIONS!!!!!

Conceptual Framework & Acctg. Standards (by: Zeus Vernon B. Millan) 43